The US Consumer Gets Some Respect

Lost in the madness of the media’s mania with Goldman Sachs this morning may have been the impressiveness of the y/y decline in consumer price inflation (see chart). The Consumer Discretionary stocks aren’t missing this – that’s why the XLY consumer index is breaking out.

Headline CPI fell by more than where the Street had their heads (in the sand), coming in -1.7% month over month, driven by a massive drawdown in energy prices which tanked by -17% month over month!

Consumer price inflation growth in the USA is now growing at a snail’s pace (lowest sequential monthly growth since the early 1960’s), and this is a screamer for the consensus “short the consumer” crowd, at least in the immediate term. While it now matters to one Warren Buffett, Goldman losing $5/share matters to less than 0.01% of this country’s population. Falling gas pump prices matters to more than 99%.

Facts don’t lie, people do. This US market’s immediate term lows are in. If the only reality is that the US consumer’s confidence is improving because it couldn’t get worse (Madoff), that’s good enough for me. It’s what matters on the margin that matters most to my macro model.KM

Keith R. McCulloughCEO & Chief Investment Officer

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12/16/08 08:11 AM EST

Are you ready for some rate cuts?

“So get ready. I mean, get ready.”
-Hank Williams Jr.

While Monday Night Football is usually past my bedtime, I did get the opportunity to hear ole Hank Williams Jr belt out “All My Rowdy Friends Are Here On Monday Night” last night. What a beauty of an American remix that song has become. We should use it as a rallying call to all global equity investors who are looking to lever up long on the FREE money “Trade!”

Our special thanks to Alan Greenspan for the beers and the “Made-Up” Madoffs. Greenspan teaching “Heli-Ben” how to party won’t end well, but man is it going to be fun! “I mean get ready!” … “We’ve got Al and Ben and Hank”… “they’re gonna get it kick started”… Are you ready for some rate cuts?! A rate cut party!

There remains an American media mania in both Fed-watching and rate-cutting that has yet to see her final Karaoke. This bar is open after hours folks – from Japan to Saudi Arabia they’re going to party like it’s 1984 all over again, crank up the tunes, and cut them rates to zero!

This morning the Saudis woke me up to another 50 basis point cut, taking their benchmark rate down to 2.5%. Since wage and imported currency inflation remains a reality of life in the Middle East, that means rates are negative now on a real basis. This was the 4th rate cut by the Saudis in the last 3 months, and now their stock market, the Tadawul Index, is havin’ a little “re-flation” party of its own, trading up +16% since November 23rd.

In Asia, with the Japanese Tankan confidence survey tanking to a 34 year low yesterday, there is a very good chance that the compromised and confused Japanese socialists cut rates to ZERO on Friday. Never mind calculating what the inflation rate does to real rates – these guys don’t do math that way – Japanese rates will potentially be nada, nominally, by year end.

In China, the equivalent of the head of the US Federal Reserve made a very important statement overnight that CNBC will not pick up on (at least not until they read my note). I think that Hank Williams might have as good a chance at guessing the name of the governor of the People’s Bank of China as anyone on the E! Channel’s newest competitor. His name is Zhou Xiaochuan, and as of last night’s speech in Hong Kong, he supports the following rate cutting message: "First we care about the cost of capital for enterprises and secondly the interest rate should be linked with CPI.”

In English, with Chinese CPI now down to +2.4% year-over-year, that gives us a new target for Chinese interest rates. “So get ready… I mean, get ready!” The Chinese just told you they can cut rates in HALF from here. This is why all Asian equity and stock markets are “Re-flating” folks. “A Monday Night party!” continued in Asia overnight with both China’s and Hong Kong’s stock markets closing up yet again. These equity markets are up over +20% and 40%, respectively, in the last few months for a fundamental reason. The math doesn’t lie, people do – especially when plenty of them just told you they were drinking the “Madoff” for the last few years.

Those who are hung-over by the madness of the storytelling on Wall Street, are likely going to be managing your money even more reactively than Paulson and Kashkari are managing the TARP. That is a scary thought - one that should be proactively prepared for, and taken advantage of. The New Reality is that Barack Obama is going to let the FREE money policy prevail, for at least the immediate term. This is the only strategy that will allow him the immediate term provision that Franklin Roosevelt sought out, “Re-Flation.”

When FDR came to the bombed out Hoover party White House, the first thing that he had his eyes on was devaluing the US Dollar via solid gold “re-flation” – if you aren’t going to raise rates (our contacts are telling us Obama won’t immediately), this is the only way out. “Re-flating” the American dreams of their portfolios and homes is where the heart is. Even “no drama” Obama has his soft spots. Incidentally, in the last 6 days of trading, gold is up +11% and the US Dollar is down -6%.

When the entertainers from Monday Night Football are as adept at calling the market as those on the channels that were built upon the largest global asset mania in world history, you have yourself plenty of reason to get ready. “So get ready… I mean, get ready” for some rate cuts!

My SP500 support level is 868.11 and I have an immediate term upside target of 914. That’s only 5.3% higher, but if I was in 100% cash all year until this morning, and tacked that yardage onto my 2008 stats, I might even beat Bernie’s “Made-Up” numbers. If it’s there for the taking – let’s go get it!

XLV Health Care Select Sector SPDR –– the American Heart Association released a statement yesterday that concluded that heart attacks and stroke deaths in the US dropped by a third between 1999 and 2006 as more people stopped smoking, ate better and had access to cholesterol lowering satins and blood thinning medications.

FXI –iShares China – China’s coal prices tumbled 9% last week. China, one of the world’s largest producers and consumer of coal, has seen price halved from record July prices to the current 580 Yuan or $83.70 a metric ton. CSI300 closed up this morning 19.42, or 0.98% to 1994.45.

Short ETFs

FXY – CurrencyShares Japanese Yen Trust –The Yen is up slightly against the USD to 89.980.

IFN The India Fund—SABMiller Plc, the world’s second-largest brewer, is challenging state governments in India to loosen the rules on beer sales, and said profit in the country may double if it wins a court case. The rupee rose 0.4% to 47.855 per USD.

Keith R. McCullough
CEO & Chief Investment Officer

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12/16/08 07:03 AM EST

MGM: DISAPPOINTING NET PROCEEDS

It has come to our attention that MGM will only generate net proceeds of around $600 million versus our projection of $700 million. This is very disappointing and brings into question why the company would pursue this transaction. Near term liquidity will be improved but the sale doesn’t help the Q2/Q3 covenant issue. MGM will still have to undertake an expensive refinancing, possibly involving equity.

The problem, of course, is that TI has a very low cost basis, as is the case with many gaming assets. The gross purchase price of $775 million seemed fair but at $600 million, MGM is only receiving around 7.0x 2009 EBITDA. This multiple is less than our projected leverage ratio. The transaction is neither accretive to equity nor does it de-lever the company.

Assuming the rest of the portfolio is worth a premium to TI, say 8x, that doesn’t leave much equity left over.

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12/15/08 04:17 PM EST

Eye On "Re-Flation"

Last week's "Re-Flation" math is pretty straightforward to look back on. It was broad based and correlated. See the chart below.

KM

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12/15/08 03:36 PM EST

THE COVENANTS DON’T CARE

MGM confirmed rumors that it is selling Treasure Island (TI). The purchase price is $775 million and we estimate net proceeds will be in the $700-725 million range after a decent sized tax bite. The company expects the transaction to close in Q2 2009, which is an important quarter for another reason. Absent new financing, we estimate MGM will trip the leverage covenant in its credit facility during that quarter. If it doesn’t happen in Q2, a covenant bust is virtually a mathematical certainty in Q3.

The TI sale looks like a non-event. Near term liquidity is improved but the multiple was just ok. Most importantly, the covenant situation is essentially unchanged. The chart below provides estimated quarterly leverage ratios against the maximum allowable ratio as provided in the credit agreement. This is the biggest issue facing MGM right now. Investors should expect a highly dilutive equity offering in the coming months or a sharp rise in the company’s borrowing rate should they choose to renegotiate their credit facility. Neither of these options will be good for the current equity.

It's a bust!

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12/15/08 03:22 PM EST

SP500 Levels Into The Close...

Today’s failure to breakout through the “shark line” (SP500 867) to our immediate term target of SP500 916 is what it is for now – wrong. We try our best to call markets and how they interact, daily. This is not an excuse. This is what it is – we won’t be right 100% of the time, but we will miss 100% of the shots that we don’t take (Gretzky).

As I am writing this note, the SP500 is testing its lows of the day at 859. From that line, the balance of risk/reward is very straightforward, playing to the bullish side’s favor. Downside is -2% from here; upside is +6.5%.

BUY “Trade” = 841.11SELL “Trade” = 915.68

“Heli-Ben” will be dropping moneys from the heavens in t-minus 24 hours. That will be bullish, on balance, for stocks.KM

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